VAT’s the noise about

In an open economy, we cannot afford to have the existing first-point sales-tax, which tends to raise consumer prices by an amount higher than what accrues to the exchequer due to the phenomenon of cascading. It results in an uncontrolled burden, which is not very clearly seen by the consumers because the tax system lacks transparency.

An economic consequence of widespread taxation of inputs relates to vertical integration of firms. Also, the existing system of sales-tax is non-neutral, interfering with the producers’ choice of inputs and with the consumers’ choice of consumption, thereby, leading to severe economic distortions.

In contrast to the existing first-point sales-tax, the proposed Value-Added Tax is a multi-point sales-tax with a set-off (for tax paid on inputs). It is collected at each stage of the production and distribution process, and, in principle, its burden falls on the final consumer alone. Since VAT avoids the deficiencies of sales-tax mentioned above, from the point of the taxpayer, the introduction of VAT should be looked upon as an opportunity to gain competitive advantage and to improve business operations.

A major economic advantage in adoption of VAT relates to its neutrality in regard to consumption as well as costs and prices. Whatever the tax rate, the element of tax does not enter into the system of costs and pricing. Hence, the consumer pays only the amount of tax. The misconception being evoked in the bandhs and strikes is primarily based on ill-informed notion. It does not make the system inflationary, except for the increase in the tax rate.

In fact, given the tax rate, the prices under VAT would decline as compared to the existing system of sales-tax, due to removal of the effect of cascading under VAT. Empirical studies attempted in many countries have indicated that the introduction of VAT has resulted in saving the cost of business operations. As per empirical surveys, 82 per cent of the taxpayers have reported savings in their operative expenses due to the introduction of VAT. In the Indian context, a study of CenVAT indicates that during April 1986 and September 1987, there was reduction in the prices.

Notwithstanding the economic superiority of VAT, its introduction has been opposed. This is due to lack of timely preparation on the part of tax department, which has not been able to bring out tax laws and procedures well in time. In fact, the department should take into account public reaction to laws and procedures, before these are implemented. The procedures should be so framed that the interaction of the taxpayers with the tax department is minimised. Also, a charter of demands for the taxpayers should be prepared and due care should be given to client services. Under no circumstances the laws should incorporate the irritants like entry tax.

Structural issues in the proposed VAT have also been important. One of the issues relate to floor rate, which has been pegged at a high level of 12.5 per cent. The acceptability of VAT would have been very high if the floor rate of VAT was fixed at 8 per cent. The states wanting to have high rate could always have rate higher than the floor. This would take care of the tax effort and taxable capacity of the states. There seems to be no rationale in having the same rate in, say, Nagaland and in Maharashtra.

In addition, it has been rightly pointed out that CST and VAT do not go hand in hand. It must be reduced to zero to make India a unified market. While it has been decided that all the commodities sent out of state would be given input credit for the state tax that has gone into it; and the existing CST would be reduced to 2 per cent this year, it does not remove the tax barriers in the interstate trade. The treatment meted to consignment transfers would be a serious problem for industries having all-India character.

Prior to the introduction of VAT, it is important to take care of the psychological aspects that relate to taxpayers who are bothered about compliance costs in terms of money and time needed for it. In this context, it is important that the requisite information is provided and due publicity of the new tax is given. Experiences of countries that have gone in for VAT suggest that it is indeed important that taxpayers first fully comprehend the new legislation. This will not cause any resistance and compliance problems. For the introduction of VAT, an adequate information campaign aimed both at taxpayers and consumers is important.

For taxpayers, VAT is associated with fears and rewards. Consequently, preparation on their part is crucial for its success. While such preparations would be different for small and large dealers, depending upon the provisions in the respective tax laws, the general approach is to provide small dealers with a simple scheme of turnover tax based on certain criteria. Most state laws have, however, misunderstood this phenomenon. They treat this as a means of keeping these dealers out of VAT regime, which is absolutely an incorrect approach.

These dealers should be allowed to issue invoice to the consumers showing the usual VAT rate to enable their purchasers to claim set-off in their further transactions. An important aspect of preparation relates to the obligations of taxpayers in terms of accounting requirements under VAT. The differences in maintaining books of accounts between the present system of sales-tax and in the new system are crucial. A dealer has to prepare for them and accomplish changes in the accounting system before VAT is introduced. These changes are all the more important for those who are second sellers and hence do not pay any tax under the present system.

It is important that VAT is adopted in India. However, perception as well as preparation on the part of the tax department as well as taxpayers is crucial.

(The writer is Director, Foundation for Public Economics and Policy Research)